Leveraged loan investors are heading for the door. Loans have their place in investment portfolios, but as late cycle assets to hold, these are not great. The Wall Street Journal’s Sam Goldfarb calls them the “last domino to fall,” in debt markets. He writes:
While mutual funds represent just one source of demand for loans, the recent outflows have had a big market impact, leading to sharp declines in the prices of existing loans and prompting more investor-friendly terms on a shrinking supply of new loans entering the market.
To some extent, loans—often referred to on Wall Street as “leveraged loans”—are the last domino to fall in a dismal year for fixed-income investors. Investment-grade corporate bonds have already been hurt by rising interest rates, and speculative-grade corporate bonds have proved nearly as sensitive as stocks to swings in market sentiment.
Loans held up for longer partly because, unlike most bonds, they offer floating-rate coupons that are more attractive at times when the Federal Reserve is raising rates. Loans also sit atop corporate capital structures, typically leading to lower losses in bankruptcy proceedings.
But loans aren’t impervious to much of the gloom weighing on markets. Should U.S. economic growth slow considerably next year, as more investors fear, it could lead to more defaults by businesses and a slower pace of rate increases by the Fed.
“Loan markets see demand in rising rate environments” and become less appealing when investors don’t think rates are going up, said Frank Ossino, senior portfolio manager at Newfleet Asset Management.
The recent downturn in loan prices is already contributing to a slowdown in borrowing, causing businesses to postpone fundraising deals or pay investors higher rates. Continued weakness in speculative-grade debt markets could eventually drag on the U.S. economy by making it harder for businesses with low credit ratings to fund investments or refinance coming bond and loan maturities.
Read more here.
Jeremy Jones, CFA
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